Friday, January 25, 2008

The "Real" Gold Price

Now that the gold price has climbed above the $850 high reached back in January 1980, many are proclaiming that the gold price is at a new ‘record’. That’s true of course when gold’s exchange rate to the dollar is viewed in terms of nominal dollars, but nominal dollars provide a distorted picture.

After all, everyone knows that because of inflation a dollar today purchases much less than it did twenty-eight years ago, so clearly, $850 today does not have the purchasing power it did back then. The question therefore arises, what price does gold have to reach in inflation adjusted dollars to equal the purchasing power of eight hundred fifty 1980-dollars?

The answer to this question depends upon which Consumer Price Index is used to calculate the inflation adjusted gold price. The two alternatives are the US government’s CPI or the CPI provided by John Williams of www.ShadowStats.com.

These two different CPI measures provide very different inflation adjusted gold prices. So which CPI should we use?

The ShadowStats CPI eliminates the changes made by the US government since the early 1980s to its own CPI measure. In other words, the ShadowsStats CPI is the same one the US government used to calculate inflation while Jimmy Carter was president.

The changes made by the government to its CPI were clearly introduced to lessen reported CPI inflation. A lower inflation rate reduces the cost-of-living increases the US government makes to welfare and Social Security recipients, thereby reducing its budget deficit. Welfare and Social Security recipients suffer the consequences. Their purchasing power is reduced because the payments they receive do not keep up with the real rate of inflation.

An example will be useful to illustrate this loss of purchasing power. Let’s assume that a recipient received $850 per month from the US government in January 1980. Using the US government’s CPI, that recipient is today receiving $2,310. However, if the US government had not made any changes to the way it calculates CPI, the recipient would today be receiving $6,255. This difference can be seen in the following chart, which presents the January $850 gold price adjusted for inflation using both CPI’s.

There are a couple of important conclusions from the above chart. First, gold at its present price of $900 today is still very cheap. In other words, it is a long way from the purchasing power an ounce of gold achieved in January 1980. Second, both measures on the above chart show that the dollar is losing purchasing power every month. So if gold in the future were to reach a $6,255 gold price, the inflation between now and then would require gold to reach an even higher price to equal the purchasing power it had in January 1980.

Rather than reduce inflation, the US government instead shot the messenger. By fiddling with the CPI, the US government wants us to believe that inflation is not as bad as it really is, which is the same strategy it has pursued with the other important inflation messenger – gold. Government interventions to cap the gold price prevent the gold barometer from alerting everyone that inflation is a growing menace.

To conclude, even though gold is trading at a record high in terms of nominal dollars, the real gold price is far below the old January 1980 record when adjusted for inflation. Gold is still good value, and more importantly, government interventions have kept gold cheap, thus enabling us to buy gold at gold prices far less than would be the case if the government wasn’t intervening. Therefore, continue to spend overvalued dollars to accumulate undervalued gold.